“Double, double toil and trouble; Fire burn and caldron bubble.” So sing the three witches of Macbeth as they add ingredients into their toxic brew. But while the famous chant is what is remembered from the scene, William Shakespeare spends far more time detailing each ingredient that goes into the pot. So Monday, as markets experience the highest fear factor since the COVID-19 pandemic, it’s worth taking a moment to understand what is—and what isn’t—contributing to actual danger.

An instigating ingredient added this past weekend was the disappointing jobs report released on Friday. Analysts expected 180,000 jobs—which would signal a slowdown but still relatively healthy job growth. This was, it seems, what the Federal Reserve expected last Wednesday when it decided not to cut interest rates and its chair, Jerome Powell, said, “the labor market has come into better balance.”

Instead, 114,000 jobs were created in July. This was disappointing, and some believed it signaled that the United States is headed for slower growth than forecast and even—dare one say the dreaded word—a recession. But within a day or two, most market participants had taken a deep breath, recognizing that bad weather probably had an impact, remembering that unemployment was still near historic lows, and aware that US gross domestic product growth was far outpacing that of the rest of the Group of Seven (G7).

Then Japan happened. As several financial commentators have noted, a unique mix of problems is plaguing Japanese markets. The Bank of Japan had stuck to zero interest rates during the global cycle of rate hikes but was forced to intervene last week to avoid further yen depreciation. This now means that Japanese borrowing conditions are becoming tighter as recession risks grow, making it an outlier during the coming easing cycle—just as it was during the global cycle of rate hikes. The record Nikkei index rout on Monday can also be attributed to the export-oriented nature of Japanese firms, which had benefited from the weak yen, until now.

So why then did US markets react so violently Monday? It’s not just the jobs report and it’s not just Japan. Instead, it’s the x-factor ingredient—geopolitics. Specifically, Iran’s likely imminent attack on Israel, as retribution for the assassination of Hamas political leader Ismail Haniyeh in Iranian territory.

Pricing in geopolitics is almost always an impossible task for Wall Street. Speculation about equity markets is one thing. Speculation about Ayatollah Ali Khamenei’s intentions is usually far outside traders’ field of expertise. With more uncertainty comes more fear—see the VIX index, which is essentially Wall Street’s fear gauge, below—surprisingly showing that the market is more concerned now than it was during Silicon Valley Bank’s collapse in March 2023. In fact, it’s the highest volatility reading since the COVID-19 pandemic, rivaling volatility during the global financial crisis.

What’s especially hard for markets is to navigate a geopolitical crisis intertwined with bad economic news. Individually, either one can be mitigated and hedged against. But together, the two developing at the same time create a haze that can make each situation appear more threatening than it actually is. How then do we find solid ground? Focus on the data.

The US economic data remains strong. The economy is slowing, but it is nowhere near a recession. And in fact, as the chart below shows, it could slow significantly before falling to the level of its G7 peers.

Moreover, data released Monday show that economic activity in the service sector grew more than expected. And remember that the United States is still creating new jobs, even if at a slower pace than before. Gas prices are significantly lower than two years ago at the outset of Russia’s full-scale invasion of Ukraine. So even if a crisis widens in the Middle East, a slower global economy should keep price increases in check.

Meanwhile, inflation is finally coming back down to the Federal Reserve’s target range of 2 percent. All this signals an economy that is, as long forecast, coming off its breakneck pace. The Federal Reserve should probably have acted sooner by cutting rates last week, but to jump into an emergency session as some have called for is not supported by the data right now and risks creating more panic. The economic fundamentals remain stable.

Geopolitical tensions actually present the greater risk to markets. No one knows how and when Iran will retaliate and what the fallout will be. And as I wrote in February, the relative weakness of the region’s economies means any worsening of the situation could send multiple countries into debt distress and trigger more market failures.

Still, the overwhelming likelihood is that whatever develops in the Middle East this week will be contained to the Middle East. While that may impact energy prices, it is unlikely to trigger wider global economic fallout. To be sure, nothing is guaranteed. The situation could deteriorate and the worst fears could be realized. But it is not the most likely outcome.

So in the days ahead, it’s geopolitical tensions that will likely move the markets more than the macroeconomics. Watch carefully in the coming days (or as Macbeth would say, “tomorrow, and tomorrow, and tomorrow”) as markets recognize this reality and, hopefully, cooler heads prevail.

Josh Lipsky is the senior director of the Atlantic Council’s GeoEconomics Center and a former adviser at the International Monetary Fund.

Data visualizations created by Alisha Chhangani, Mrugank Bhusari, and Sophia Busch.

Further reading

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Image: Traders work on the floor at the New York Stock Exchange (NYSE) in New York City, U.S., May 17, 2024. REUTERS/Brendan McDermid/File Photo